Buy This Stock and Weather the Gaming Storm

Consumers of video games have changed over the last decade. The explosive rate of adoption for Android and iOS has brought on an entirely new class of casual gamers. This unprecedented opportunity has created a headache for the top publishers of yesteryear. They were never built for a model where $1 casual gaming has become the norm. If such publishers were to fully embrace this reality, it would likely threaten revenue, putting them at risk.

To make matters worse, the last three months of hardware sales have been a nightmare:

Month

Yearly Change

September

(39%)

October

(37%)

November

(13%)

Source: NPD Group.

Today's consoles have become long in the tooth, a driving factor behind such poor September and October results. When November rolled around, Black Friday, holiday promotions, and the new Wii U console from Nintendo helped slow the bleeding. But even with these stimulative measures, it wasn't enough to reverse the decline.

Upcoming console refreshes from Microsoft and Sony are expected to improve uptake, but that's not guaranteed. It's entirely possible we've entered a post-gamer glory period, thanks primarily to powerful smart devices with $1 games. Combined, these factors have hurt the population of diehard gamers, and the ones who remain committed buy fewer games.

This is quite the predicament for some of the biggest publishers, including Activision Blizzard , Electronic Arts , and Take-Two Interactive . Let's dive into the details and see which is most fit to weather the storm.

By the numbersHere's a quick breakdown of each company's quarterly revenue mix:

Activision and Take-Two both had blockbuster releases skewing their growth rates. Activision enjoyed a strong release of Diablo III and Take-Two benefited from Borderlands 2 and Grand Theft Auto IV bringing home a lot more bacon than last year. The ebb and flow of blockbuster releases makes it difficult to see the underlying deterioration of the core gaming market. In other words, these companies are competing in an industry that has lost some luster.

The issue I have with digital growth is the risk these publishers run by replacing one type of revenue for another. If that's the best they can do, the long-term story becomes questionable. Looking at the lineup, EA is experiencing the most dramatic shift. While it has made excellent progress with digital, it wasn't enough to make up for the decline in physical gaming.

Although there isn't a clear winner here, it's clear how vulnerable the current industry is to revenue shifts.

The power of loyaltyHigh subscriber counts are a publisher's dream. They are the proverbial bread and butter of cash flow and build a solid foundation of reliability. It's really no contest here. Activision's World of Warcraft boasts over 10 million subscribers, accounting for 27% of its total revenue last quarter. The closest competitor would be EA, with 2 million subscribers for its Battlefield 3. Take-Two doesn't currently employ a subscriber-based model, but it's involved in the add-on gaming business.

Sizing up the moatHere's a quick peek at some moat-worthy metrics:

Company

Total Cash

Debt-to-Equity

Gross Profit Margin

Net Profit Margin

Activision Blizzard

$2,909

0

63%

20%

Electronic Arts

$871

0.26

62%

0.4%

Take-Two Interactive

$328

0.67

34%

(20%)

Sources: Schwab.com, YCharts, and quarterly filings. All dollar amounts are in millions.

In terms of profitability, staying power, and overall financial strength, Activision has it made.

Drum roll, please!When an industry faces uncertain times ahead, investing in companies with the highest relative strength is essential. By now, the answer should be increasingly clear that Activision is the best-in-class investment. It has the lowest console exposure, the highest PC exposure, the largest subscriber base, and the biggest moat to weather an uncertain future. For now and the foreseeable future, the PC gaming market remains well insulated from the threat of smart devices. Combined, these factors make it easy to see why Activision remains a buy candidate in my book.

The bigger pictureWhile Activision and Microsoft have been taking the headlines when it comes to console gaming, Fools following the gaming sector would do well to also keep tabs on Electronic Arts. We can help. Our new special report breaks down the risks and opportunities facing the company to help you decide if EA is right for your portfolio. Click here to get your copy now and we'll throw in a year of free quarterly updates as news breaks.